W hen you walk into a store, you are confronted with thousands of goods that
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CHAPTER 21 the theOrY OF CONSUMer ChOICe 459 2. Compare the following two pairs of goods: • Coke and Pepsi • Skis and ski bindings a. In which case are the two goods complements? In which case are they substitutes? b. In which case do you expect the indifference curves to be fairly straight? In which case do you expect the indifference curves to be very bowed? c. In which case will the consumer respond more to a change in the relative price of the two goods? 3. You consume only soda and pizza. One day, the price of soda goes up, the price of pizza goes down, and you are just as happy as you were before the price changes. a. Illustrate this situation on a graph. b. How does your consumption of the two goods change? How does your response depend on in- come and substitution effects? c. Can you afford the bundle of soda and pizza you consumed before the price changes? 4. Mario consumes only cheese and crackers. a. Could cheese and crackers both be inferior goods for Mario? Explain. b. Suppose that cheese is a normal good for Mario while crackers are an inferior good. If the price of cheese falls, what happens to Mario’s consumption of crackers? What happens to his consumption of cheese? Explain. 5. Jim buys only milk and cookies. a. In year 1, Jim earns $100, milk costs $2 per quart, and cookies cost $4 per dozen. Draw Jim’s budget constraint. b. Now suppose that all prices increase by 10 percent in year 2 and that Jim’s salary increases by 10 percent as well. Draw Jim’s new budget constraint. How would Jim’s optimal combination of milk and cookies in year 2 compare to his optimal combination in year 1? 6. State whether each of the following statements is true or false. Explain your answers. a. “All Giffen goods are inferior goods.” b. “All inferior goods are Giffen goods.” 7. A college student has two options for meals: eating at the dining hall for $6 per meal, or eating a Cup O’ Soup for $1.50 per meal. Her weekly food budget is $60. a. Draw the budget constraint showing the trade-off between dining hall meals and Cups O’ Soup. Assuming that she spends equal amounts on both goods, draw an indifference curve showing the optimum choice. Label the optimum as point A. b. Suppose the price of a Cup O’ Soup now rises to $2. Using your diagram from part (a), show the con- sequences of this change in price. Assume that our student now spends only 30 percent of her income on dining hall meals. Label the new optimum as point B. c. What happened to the quantity of Cups O’ Soup consumed as a result of this price change? What does this result say about the income and substitu- tion effects? Explain. d. Use points A and B to draw a demand curve for Cup O’ Soup. What is this type of good called? 8. Consider your decision about how many hours to work. a. Draw your budget constraint assuming that you pay no taxes on your income. On the same diagram, draw another budget constraint assuming that you pay 15 percent tax. b. Show how the tax might lead to more hours of work, fewer hours, or the same number of hours. Explain. 9. Sarah is awake for 100 hours per week. Using one dia- gram, show Sarah’s budget constraints if she earns $6 per hour, $8 per hour, and $10 per hour. Now draw in- difference curves such that Sarah’s labor-supply curve is upward sloping when the wage is between $6 and $8 per hour, and backward sloping when the wage is between $8 and $10 per hour. 10. Draw the indifference curve for someone deciding how to allocate time between work and leisure. Sup- pose the wage increases. Is it possible that the person’s consumption would fall? Is this plausible? Discuss. (Hint: Think about income and substitution effects.) 11. Consider a couple’s decision about how many chil- dren to have. Assume that over a lifetime a couple has 200,000 hours of time to either work or raise children. The wage is $10 per hour. Raising a child takes 20,000 hours of time. a. Draw the budget constraint showing the trade-off between lifetime consumption and the number of children. (Ignore the fact that children come only in whole numbers!) Show indifference curves and an optimum choice. b. Suppose the wage increases to $12 per hour. Show how the budget constraint shifts. Using income and substitution effects, discuss the impact of the change on the number of children and lifetime consumption. c. We observe that, as societies get richer and wages rise, people typically have fewer children. Is this fact consistent with this model? Explain. 65875_ch21_ptg01_433-460.indd 459 15/10/13 11:53 AM Copyright 201 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. |